Bank of Japan Asset Purchases Continue to Slow Sharply

The pace of asset purchases by the Bank of Japan (BOJ) has continued to slow sharply in 2018 to an annual rate of around JPY45 trillion (USD410 billion) despite the official commitment to annual purchases of around JPY80 trillion.

While BOJ monetary policy remains extremely accommodative and the scale of asset purchases is still large, this "stealth" tapering is occurring as the European Central Bank (ECB) has recently announced its intention to phase out QE by the end of this year, the Fed's balance sheet shrinks at an increasing pace and the Bank of England (BOE) has lowered the threshold for interest rates above which it will start reducing its balance sheet. BOJ purchases are expected to continue to step down over the next few years, supporting the likelihood of a transition to global quantitative tightening - shrinking balance sheets for the four QE central banks (BOJ, BOE, ECB and Fed) in aggregate - over the medium term.

The BOJ started to scale back its purchases of government bonds (JGB) quite sharply after the introduction of its Yield Curve Control (YCC) policy in September 2016. As the chart of the month shows, while the BOJ was buying around JPY80 trillion of JGB annually in 2015 and 2016 (USD700 billion at average annual market exchange rates), it has stepped down its purchases dramatically since then, down to JPY56 trillion in 2017 (USD496 billion), and currently to a level consistent with around JPY45 trillion annualised (USD410 billion).

The announcement of the 0% target for nominal JGB 10-year yields as the main monetary policy goal implied a more passive approach towards balance sheet size, as the BOJ effectively committed itself to purchasing assets on whatever scale would be needed to control the price (and yield) of JGBs. Since the private sector's demand for JGBs fluctuates in response to factors outside the BOJ's control, such as FX rates, overseas yields, inflation expectations and global investor risk aversion, the bank could no longer pre-determine the scale of its purchases, in contrast to the quantity-based policy framework that existed prior to September 2016. As the chart shows it has taken far fewer than JPY80 trillion of annual purchases to secure the 0% yield target.

One reason for this is the diminishing share of the stock of JGBs held by the private sector. This implies that that a lower rate of official purchases can have a greater impact on yields, and so the BOJ needs to buy less JGBs to have the same impact on yields. The BOJ currently holds 46% of the outstanding government securities stock (JGBs plus short-term bills), up from less than 14% before large-scale QE started in 2013.

The BOJ may have avoided announcing a reduction in the targeted pace of asset purchases to avoid perception that it is reducing the degree of monetary stimulus as it seeks to restore inflation expectations. There is little doubt that the BOJ continues to pursue a highly aggressively accommodative stance as the other three QE central banks have begun or are approaching the slow process of normalisation. But it seems increasingly clear that the BOJ's less specific policy commitment to "keep expanding the monetary base until inflation is above 2%" is the more important target on the balance sheet side.

In this context ,Fitch's view is that inflation will remain firmly below the 2% target through 2020, once the temporary effect of the consumption tax hike scheduled in late 2019 fades away. Structural impediments to wage growth in the labour market will remain. Inflation has softened in recent months, falling to 0.6% yoy in May from 1.5% yoy in February. We expect it will only modestly pick up from there, on the back of accelerating fuel prices. On the basis of this inflation forecast, Fitch expects BOJ monetary policy to remain extremely accommodative but for the pace of asset purchases to fall gradually to around JPY20 trillion (USD180 billion) in 2020 from around JPY40 trillion (USD360 billion using GEO exchange rate forecasts) this year.